Chapter 10 Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics Answers

Financial Markets and Institutions, 8e (Mishkin)

Chapter 10 Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics

1) Assets on the Fed's balance sheet include government securities and discount loans.

2) The monetary base consists of

• currency in circulation and reserves.

3) An open market purchase of securities by the Fed will

• have no effect on assets of the nonbank public but increase assets of the Fed.

4) An open market sale of securities by the Fed will

• decrease liabilities of the Fed and not affect assets of the banking system.

5) If the Federal Reserve wants to expand reserves in the banking system, it will purchase government securities.

6) If the Federal Reserve wants to lower the monetary base and the money supply, it will sell government securities.

7) A discount loan by the Fed to a bank causes a(n) ________ in reserves in the banking system and a(n) ________ in the monetary base.

• increase; increase

8) When a bank repays a discount loan to the Fed, there is a(n) ________ in reserves in the banking system and a(n) ________ in the monetary base.

• decrease; decrease

9) The federal funds rate is

• the interest rate on loans of reserves from one bank to another.

10) The discount rate is

• the interest rate on loans from the Fed to a bank.

11) Holding everything else constant, if the federal funds rate rises, then the demand for excess reserves falls because they have a higher cost.

12) Holding everything else constant, if the federal funds rate falls, then the demand for excess reserves rises because they have a lower cost.

13) Bank reserves can be categorized as vault cash and deposits at the Fed.

• required reserves and excess reserves.

• borrowed reserves and nonborrowed reserves.

14) An open market purchase

• shifts the supply curve for reserves to the right and causes the federal funds rate to fall. 15) The supply curve for reserves is ________ when the federal funds rate is below the discount rate and ________ when the federal funds rate is above the discount rate.  vertical; horizontal

16) The supply curve for reserves shifts to the left and the federal funds rate rises when the Fed does an open market sale.

17) The demand curve for reserves shifts to the left and the federal funds rate falls when the Fed decreases reserves requirements.

18) Under usual circumstances, an increase in the discount rate causes no change in the federal funds rate.

19) If the Fed increases reserve requirements, the demand for reserves ________ and the equilibriumfederal funds rate ________.

• increases; rises

20) The actual execution of open market operations is done at the Federal Reserve Bank of New York.

21) During 2007 as the global financial crisis started, the Fed implemented several new lending programs to increase liquidity, including ________.

• expansion of the discount window

• setting up the Term Auction Facility, making loans through competitive auctions  lending to investment banks

22) During QE1, the Fed purchased ________.

• $1.25 trillion in mortgage-backed securities 23) During QE2, the Fed purchased ________.

• $600 billion in long-term Treasury securities 24) During QE3, the Fed purchased ________.

• $40 billion in mortgage-backed securities and $45 billion in long-term Treasuries (to start) 25) The Federal Open Market Committee makes the Fed's decisions on the purchase or sale of government securities, but these purchases or sales are executed by the Federal Reserve Bank of

• New York.

26) An open market transaction intended to change the level of bank reserves is a dynamic operation.

27) If the Federal Reserve wants to drain reserves from the banking system, it will sell government securities.

28) The Federal Reserve will engage in an outright purchase if it wants to ________ reserves ________ in the banking system.

• increase; permanently

29) If the Fed wants to temporarily drain reserves from the banking system, it will engage in a matched sale-purchase transaction.

30) The Federal Reserve will engage in a matched sale-purchase transaction when it wants to ________ reserves ________ in the banking system.

• decrease; temporarily

31) Discount loans to banks experiencing severe liquidity problems are called secondary credit.

32) Discount loans to healthy banks, who may borrow as much as they wish from the Fed, are called primary credit.

33) Disadvantages of using reserve requirements to control the money supply include their overly-powerful impact on the money supply.

34) The Fed is reluctant to use reserve requirements to control the money supply because of their overly-powerful impact on the money supply.

• they have the potential to create liquidity problems for banks with low excess reserves.

• frequent changes in reserve requirements complicate liquidity management for banks.

35) When the Federal Reserve was created, its most important role was intended to be a lender of last resort.

36) At its inception, the Federal Reserve was intended to be a lender of last resort.

37) Price stability is desirable because

• inflation creates uncertainty, making it difficult to plan for the future.

38) The Federal Reserve desires interest rate stability because it allows for less uncertainty about future planning.

• interest rate volatility often leads to demands to curtail the Fed's power.

39) When workers voluntarily quit a job or decline a job offer so they can search for a better one, theresulting unemployment is called  frictional unemployment.

40) When there is a mismatch between job requirements and the skills of available workers, the resulting unemployment is called

• structural unemployment.

41) The goal for high employment should be a level of unemployment at which the demand for laborequals the supply of labor. Economists call this level of unemployment the  natural rate of unemployment.

42) Although the goals of high employment and economic growth are closely related, policies can bespecifically aimed at encouraging economic growth by  encouraging firms to invest.  encouraging people to save.

43) Although the goals of high employment and economic growth are closely related, policies can bespecifically aimed at encouraging economic growth by  encouraging firms to invest and people to save.

44) The Fed's monetary policy strategy can be described as follows:

• The Fed uses its policy tools to adjust operating targets that directly impact its intermediate targets in a way that allows the Fed to achieve its goals.

45) If the Fed's strategy for conducting monetary policy is thought of as a game plan that proceeds instages, then the game plan can be summarized as follows:

• The Fed selects its policy goals, then the intermediate targets consistent with achieving its policy goals, then the operating targets consistent with its intermediate targets. Finally, it adjusts its policy tools to effect the desired targets and goals.

46) An advantage of an intermediate targeting strategy is that it provides the Fed with more timely information regarding the effect of monetary policy.

47) Which of the following is not a requirement in selecting an intermediate target?

A) Measurability

B) Controllability

C) Flexibility

D) Predictability

• Answer: C

48) Which of the following is a potential operating target for the Fed?

A) The monetary base

B) The M1 money supply

C) Nominal GDP

D) The discount rate

• Answer: A

49) Which of the following is a potential operating target for the Fed?

• Nonborrowed reserves

• The federal funds rate

• The monetary base

50) Which of the following is not an operating target?

A) Nonborrowed reserves

B) Monetary base

C) Federal funds interest rate

D) Discount rate

• Answer: D

51) When it comes to choosing an operating target, both the ________ rate and ________ aggregatesare easily controllable using the Fed's policy tools.  federal funds; reserve

52) If the desired intermediate target is an interest rate, then the preferred operating target will be a(n) ________ variable like the ________.  interest rate; federal funds rate

53) If the desired intermediate target is a monetary aggregate, then the preferred operating target willbe a(n) ________ variable like the ________.  reserve aggregate; monetary base

54) If the Fed uses nonborrowed reserves, a reserve aggregate, as a target, fluctuations in the reserves demand curve will cause ________ to fluctuate.  the federal funds interest rate

55) If the Fed uses nonborrowed reserves, a reserve aggregate, as a target, an increase in the demand for reserves will result in a(n) ________ in ________.  increase; the federal funds interest rate

56) If the Fed uses the federal funds rate as an interest rate target, fluctuations in the reserves demand curve will cause ________ to fluctuate.  nonborrowed reserves

57) If the Fed uses the federal funds rate as an interest rate target, an increase in the demand for reserves will result in a(n) ________ in ________.  increase; nonborrowed reserves

58) Under inflation targeting, a central bank must pursue policies that keep the inflation rate within a specific target range.

59) The first country to mandate that its central bank adopt inflation targeting was

• New Zealand.

60) Banks' holding of deposits in accounts with the Fed, plus currency that is physically held in banks are called

• reserves.

61) An open market ________ leads to a(n) ________ of reserves and deposits in the banking systemand hence to a(n) ________ of the monetary base and the money supply.  purchase; expansion; expansion

62) Regulations making it obligatory for depository institutions to keep a certain fraction of their deposits in accounts with the Fed are  reserve requirements.

63) Which type of open market operation is intended to change the level of reserves? Dynamic open market operations

64) The type of open market operation intended to offset movements in other factors that affect reserves and the monetary base is

• the defensive open market operations.

65) What goals are continually mentioned by central bank officials when discussing the objectives ofmonetary policy?

• Interest-rate stability

66) Which of the following statements is correct, concerning price stability as a monetary goal?

• In the long run, no inconsistency exists between the price stability goal and the

• In the short run price stability often conflicts with the goals of high employment and interestrate stability.

67) Which of the following statements is correct, concerning price stability as a monetary goal?A) In the long run, inconsistencies exists between the price stability goal and the other goals, such as high unemployment.

B) In the short run price stability does not conflict with the goals of high employment and interest-rate stability.

• Neither A nor B is true.

68) The Bank of England, as well as the ECB, put price stability first among all goals. This is known as a ________.

• hierarchical mandate

69) The Fed puts price stability along with maximum employment as its primary goals. This is known as a ________.

• dual mandate

70) Hierarchical mandates can cause a problem that Mervyn King, Governor of the Bank of England, refers to as an "inflation nutter," that can lead to large ________.

• output fluctuations

71) Inflation targeting involves

• a public announcement of medium-term numerical targets for inflation.

72) During the 2007-2009 financial crisis, what actions did the Fed take to limit the scope of the crisis?

• The Fed lowered the spread on the discount rate to 50 basis points, and then to 25.

• The Fed set up the Term Auction Facility to provide further liquidity to banks.

• The Fed purchased assets of Bear Stearns to facilitate the purchase of Bear Stearns by J.P. Morgan.

73) Which of the following statements is true regarding the Fed's procedures for operating the discount window?

• The Fed's operating procedures and paying interest on reserves contains the federal funds rate between the interest rate paid on reserves and the discount rate.

74) Which of the following statements is true?

A) Credit-driven asset bubbles are particularly dangerous. When asset prices fall, the deleveraging of credit markets reduces economic activity.

B) Bubbles driven soley by irrational exuberance lead to a failure of financial institutions.

• Answer: A

75) If the Fed wants to "prick" an asset-pricing bubble driven by a credit boom, what is the primary tool for accomplishing this?

• Raising interest rates

76) In response to an asset-price bubble, macroprudential regulation appears to be the right tool.

What is macroprudential regulation?

• Regulatory policy to affect what is happening in credit markets in the aggregate

77) As of June 2013, the consolidated balance sheet of the Federal Reserve System included about ________ in assets.

• $3.5 trillion

1) An objective of the Federal Reserve in its conduct of monetary policy is high employment.* TRUE

2) When workers voluntarily leave work while they look for better jobs, the resulting unemploymentis called frictional unemployment. * TRUE

3) The discount rate is an operating target.* FALSE

4) The federal funds rate is an operating target.

* TRUE

5) Open market purchases by the Fed increase the supply of nonborrowed reserves.* TRUE

6) Open market purchases by the Fed cause the federal funds rate to rise.* FALSE

7) Flexibility is a requirement in selecting an intermediate target.* FALSE

8) Inflation targeting makes the central bank less accountable.

* FALSE

9) An open market sale leads to an expansion of reserves and deposits in the banking system and hence to a decline in the monetary base and the money supply.

* FALSE

10) Decreased transparency of the monetary policy strategy through communication with the public and the markets about the plans and objectives of monetary policymakers is an element of inflation targeting.

* FALSE

11) The Fed's operating procedures and paying interest on reserves contains the federal funds rate between the interest rate paid on reserves and the discount rate.

* TRUE

12) An important lesson from the global financial crisis is that central banks and other regulators should have a laissez-faire attitude and let credit-driven bubbles proceed without any reaction. Intervention is always a mistake. * FALSE

13) Quantitative easing and credit easing are essentially the same thing.

* FALSE

14) In the long run, the price stability goal is inconsistent with other goals, such as economics growth, stability of financial markets, etc.

* FALSE

15) The natural rate of unemployment is not lowered by high inflation, so higher inflation cannot produce lower unemployment or more employment in the long run.

* TRUE

16) In the short run, price stability often conflicts with the goals of high employment and interestrate stability.

* TRUE

10.3 Essay

1) Explain how the Fed's use of its three tools of monetary policy affect supply and demand in the market for reserves and the equilibrium federal funds interest rate.

Topic: Chapter 10. 2 The Market for Reserves and the Federal Funds Rate

2) Distinguish between the three types of Fed discount loans: primary credit, secondary credit, and seasonal credit.

Topic: Chapter 10. 3 Conventional Monetary Policy Tools

3) Why does the Fed use open market operations to a greater extent than reserve requirements in its conduct of monetary policy?

Topic: Chapter 10. 4 Reserve Requirements

4) Explain why the use of an interest rate targeting strategy may result in procyclical monetary growth.Topic: Chapter 10.10 Inflation Targeting

5) "The interest rate targeting strategy employed by the Fed in the 1960s and 1970s led to procyclical money growth." True, false, or uncertain? Why? Topic: Chapter 10.10 Inflation Targeting

6) If inflation and unemployment are of direct concern to Fed officials, why do they make such a big issue about money growth and interest rates? Why don't they just target the unemployment rate and the inflation rate directly? Explain.

Topic: Chapter 10.10 Inflation Targeting

7) Describe the goals of the Federal Reserve. What happens when these goals come into conflict? How would one decide if lower inflation is more important than lower unemployment? Explain. Topic: Chapter 10. 8 Other Goals of Monetary Policy

8) Can the Fed control the money supply? Has it done so? What evidence can you provide to support your answer to each question?

Topic: Chapter 10. 3 Conventional Monetary Policy Tools

9) Compare the advantages and disadvantages of monetary targeting and inflation targeting.Topic: Chapter 10.12 Tactics: Choosing the Policy Instrument

10) Describe what criteria is applied when choosing a policy instrument.

Topic: Chapter 10.12 Tactics: Choosing the Policy Instrument

11) Describe and discuss Chairman Bernanke's views on inflation targeting and transparency in central banking.

Topic: Chapter 10.10 Inflation Targeting

12) Distinguish between a hierarchical mandate and a dual mandate, with regard to central bank goals.Topic: Chapter 10. 9 Should Price Stability Be the Primary Goal of Monetary Policy?

13) Discuss some of the issues central banks will face maintaining price stability as a short-run goal?Topic: Chapter 10. 9 Should Price Stability Be the Primary Goal of Monetary Policy?

14) Discuss the role of the Fed as a lender of last resort during the 2007-2009 financial crisis.

Topic: Chapter 10. 5 Nonconventional Monetary Policy Tools and Quantitative Easing

15) What is the argument for the Fed paying interest to banks on required reserves? Are there good argumentsfor not doing this?

Topic: Chapter 10. 4 Reserve Requirements

16) Discuss how the monetary policy of the European Central Bank is similar to the U.S. How are they different?

Topic: Chapter 10. 6 Monetary Policy Tools of the European Central Bank

17) Describe an asset-price bubble.

Topic: Chapter 10.11 Should Central Banks Respond to Asset-Price Bubbles? Lessons from the Global Financial Crisis

18) What are the arguments for and against central bank intervention during asset-price bubbles?

Topic: Chapter 10.11 Should Central Banks Respond to Asset-Price Bubbles? Lessons from the Global Financial Crisis

19) Discuss the unconventional liquidity provisions implemented by the Fed in 2007. Topic: Chapter 10. 5 Nonconventional Monetary Policy Tools and Quantitative Easing

20) Discuss the differences between quantitative easing and credit easing.

Topic: Chapter 10. 5 Nonconventional Monetary Policy Tools and Quantitative Easing

21) Discuss how altering the composition of the Fed's balance sheet can stimulate the economy.

Topic: Chapter 10. 3 Conventional Monetary Policy Tools

22) List and describe the various assets and liabilities making up the consolidated balance sheet of the FederalReserve System.